Some time ago, Deutsche Bank's chief international economist, Torsten Slok, presented several charts which showed that "Canada is in serious trouble" mostly as a result of its overreliance on its frothy, bubbly housing sector, but also due to the fact that unlike the US, the average household had failed to reduce its debt load in time. Additionally, he demonstrated that it was not just the mortgage-linked dangers from the housing market (and this was before Vancouver and Toronto got slammed with billions in "hot" Chinese capital inflows) as credit card loans and personal lines of credit had both surged, even as multifamily construction was at already record highs and surging, while the labor market had become particularly reliant on the assumption that the housing sector would keep growing indefinitely, suggesting that if and when the housing market took a turn for the worse, or even slowed down as expected, a major source of employment in recent years would shrink. Fast forward to today, when the trends shown by Slok two years ago have only grown more acute, with Canada's household debt continuing to rise, its divergence with the US never been greater... ... making the debt-service ratio disturbingly sticky. Making matters worse, recent trends in average hourly earnings show that if the US Federal Reserve is concerned with US wages, then the Bank of Canada should be positively terrified. As BMO writes today, the chart above "looks at the 2-year change (expressed at annualized rates), which takes out some of the wonkiness in monthly readings. It’s pretty clear that the trend in U.S. wages has moved up from a sub-2% pace in the early years of the recovery to around 2.5% now. Not a huge move, but still significant. On the other hand, Canadian 2-year wage trends have collapsed to barely above 1.5%, after being above the U.S. pace for most of the recovery. This is a much bigger concern/issue than the modest cooling in U.S. wages in the past few months (which could just be a statistical quirk)." And yet despite all these concerning trends, virtually all of these red flags have been soundly ignored, mostly for one reason: the "wealth effect" in Canada courtesy of its housing market grew, and grew, and grew... Looking at the chart above, last month Bloomberg said: On a real basis, Canadian housing prices experienced a much smaller, shorter decrease in prices during the financial crisis and a much larger, longer increase in prices during the recovery. When you couple this unfathomable rise in housing prices with near-record high household debt-to-income ratios, the Canadian housing bubble starts to look scary should the tide turn. ... and added: No one knows when insanity like this will come to an end. Bubbles are like an avalanche. The longer they build up, the worse they will be when they eventually destabilize. Well, nobody may know, but as Harley Bassman said yesterday, one can make an educated assumption, and as he said it most likely will be the result of higher rates. Which brings us to today's decision by the Bank of Canada to hike its rates for only the first time since 2010, sending the Loonie to the highest level since August 2016. But aside from the surging currency, now that Canada has set off on a rate-hiking path, it has a bigger problem, one whose absence for so many years allowed the "Canadian housing bubble" in Bloomberg's words to flourish: suddenly rising rates. As CBC reports, Canada's five biggest financial institutions immediately increased their prime interest rates on Wednesday, shortly after the BOC hiked by 0.25bps. The Royal Bank of Canada was the first to announce an increase, followed by TD Canada Trust, Bank of Montreal, Scotiabank and CIBC. Effective Thursday, the prime rate at the five banks will rise to 2.95 per cent from 2.7 per cent, matching the 0.25 percentage point increase to the Bank of Canada's overnight rate. But the bigger problem is not so much rising short-term rates, but what is going on on the long end: it is here that the pain for the housing market will be most acute, because as 5Y rates have doubled in the recent past, the 10Y yield is now at the highest level it has been since May 2015 and rising fast. And as US homebuyers from the time period 2004-2006 remember all too vividly, there is nothing that will burst a housing bubble faster than a spike in mortgage rates. Which is why while Torsten Slok's original warning that "Canada Is In Serious Trouble" two years ago may have been premature, this time it appears all too real thanks to none other than the Canadian central bank, which may just have done the one thing that will finally burst the country's gargantuan housing bubble. Finally, for those skeptical, here is David Rosenberg explaining why he is 'skeptical' about BoC's view of a robust economy ahead...
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"Canada Hasn't Seen A Bank Run Such As This In Decades" - Finance Minister Says Home Capital Bailout Is Possible
When we first said three weeks ago that the spectacular, sudden implosion of Canada's largest alt-lender Home Capital Group or HCG - whose fate we had followed closely since 2015 - was Canada's own "New Century Moment", the parallels were more than just the obvious: like in the US, it took the market nearly a year to realize the full implications of the subprime collapse which first manifested in the failure of New Century and its subprime lender peers. When all was said and done, the world's central banks had to pump (and still do) trillions into the financial system to stop it from disintegrating. Slowly but surely, Canada is starting to appreciate just how serious the Home Capital failure is, and how the unprecedented bank run that has led to 94% of retail deposits fleeing the troubled lender... ... is just the first step of what will likely be a very painful process, which will likely culminate with either a government bailout, or a financial system on the verge of panic. Today, the Globe and Mail has published an in-depth report putting the HCG pieces together, or as the G&M itself puts it, the "dramatic story of a financial institution’s near-collapse." How quickly can a financial institution go from seemingly healthy and solvent to being on the verge of liquidation? The answer: hours. Here is the background: It was late in the evening on Sunday, April 30, when lawyers working for Home Capital Group Inc. dialled into a call with lawyers representing the company’s new lending syndicate. The troubled mortgage lender had negotiated a $2-billion credit line just days earlier, emergency money the board felt was needed to survive after a high-profile run on deposits at subsidiary Home Trust. The company planned to draw down the first $1-billion from it the next morning, May 1. But the deal was getting bogged down in a last-minute dispute over details of the funding, according to two sources familiar with the talks. As the conversation proceeded late on Sunday, it became increasingly evident that the fate of the financing was hanging in the balance. Another call at 2 a.m. on Monday ended badly with no agreement, a source said. There was no room for error. Home Capital was hours from the start of its business day, and it was critically low on capital. The board had determined the company could not open its doors for business Monday morning without the financing in place, the sources said. As the dispute continued, officials from Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), were on standby to launch a process to take control of the company Monday, a move that would have almost certainly forced some form of wind-up of Home Capital’s business, the sources said. In the end, some time prior to 7 a.m., the lawyers hammered out a deal on final terms of the loan, allowing the first $1-billion to be transferred Monday. When business started a couple of hours later, only a small circle of exhausted insiders knew how close the company had come to collapse. The collapse started on April 19... ... much of the unrelenting focus on the company is also due to the rarity of a financial institution failing in this country. Canada Deposit Insurance Corp. (CDIC), which insures deposits in the event of a bank failure, hasn’t paid a claim since 1996. Many commentators have pinpointed April 19 as a pivotal date when the Ontario Securities Commission unveiled an explosive enforcement case against the company and three of its executives, accusing them of making misleading disclosure to investors about mortgage underwriting problems in 2014 and 2015. But if the OSC announcement sparked a conflagration at Home Capital, it was only because there was so much dry tinder already in place to ignite. The case landed amid a broader backdrop of concern about the company’s financial condition, a loss of faith in senior management and the board, and extreme nervousness about the vulnerability of a non-prime mortgage lender deeply exposed to Toronto’s overheated housing market. ... but the seeds of failure had been planted years ago, roughly around the time we first noticed HCG and accused it of issuing "liar loans." It took regulators two years to catch up. The first alert about the OSC case, for example, emerged late on a Friday afternoon on Feb. 10, when many had already left for the weekend. Home Capital Group issued a two-paragraph release revealing it had received an enforcement notice from the OSC, relating to disclosures in 2014 and 2015 about an internal investigation that found information on some loan applications had been falsified, leading to suspensions of 45 mortgage brokers. The enforcement notice said OSC staff had reached a preliminary conclusion about problems at the company, but Home Capital still had an opportunity to respond before the commission decided whether to launch disciplinary proceedings. Why were regulators confused for so long: the answer is that unlike many comparable companies, the "ponzi scheme" at Home Capital worked at an extremely efficient pace, which created an image of stability as long as the money flowed in. However, once it stopped, all bets were off: This is precisely what emerged in February: Home Capital had no trouble writing a growing number of new mortgages for non-prime borrowers in a hot housing market last year, but it also saw many of those customers leave at the first opportunity when their mortgages came up for renewal. Borrowers at Home Capital typically sign on for one-year or two-year mortgages in the hopes of moving to a mainline bank with a cheaper lending rate once their credit history is established. That leaves Home Capital facing constant churn, analyst Jeff Fenwick of Cormark Securities said, making its retention data one of its most closely watched metrics. Of the $13.3-billion in residential mortgages on Home Capital’s books at the start of 2016, Mr. Fenwick estimates $6-billion or 45 per cent “rolled off” during the year – a rate of attrition far higher than faced by bank lenders, whose customers tend to opt for five-year mortgages. “This is one disadvantage for a lender like Home – there is a consistent treadmill of origination activity that needs to happen in order to prevent the mortgage book from shrinking,” he said. In a statement in February, Mr. Reid said the attrition rate was disappointing, telling analysts that performance in 2016 was “muted” by lower-than-expected renewals. He said improving retention would be a priority in 2017. Then the bank jog started: Canadian Imperial Bank of Commerce made a decision that would prove important, at least in hindsight. The bank issued an internal directive to financial advisers on March 28, telling them to limit their clients’ exposure in Home Trust’s GICs to the $100,000 limit insured by Canada Deposit Insurance Corp. The decision meant financial advisers had to shift assets above that cap to other institutions. Around the same time, Royal Bank of Canada made a similar move for clients of its full-service brokerage division. Bank of Montreal also imposed caps, but will not say when it introduced the limits. Home Capital would later disclose that savings account withdrawals began to mount at the end of March, around the same time that these policies were implemented. Meanwhile, Home Capital's shares started to plunge, as short sellers pounced: During the same period, short-sellers moved into overdrive to fan fears about Home Capital, while filling social-media sites with speculative claims and half-truths. Short-sellers, who bet that a company’s share price will fall, have targeted Home Capital aggressively since the summer of 2015, making it consistently one of the most-shorted companies in Canada. “The short-sellers to their credit were enormously successful in raising fear,” said a Toronto-based fund manager who held Home Capital shares. “If the short-seller’s job is to sow fear and confusion, they were very successful in doing it.” But the reak crackdown started on April 19: It was amid this worry, less than a week after the April 13 share price drop, that the OSC unveiled its allegations in the evening of April 19. While many of the main issues laid out in the statement of allegations had been previously disclosed by Home Capital, there were new details about the volume of material the company had collected in an internal investigation into its mortgage loan problems from mid-2014 to early 2015, but had not reported publicly until July, 2015, when pushed by the OSC to provide disclosure to investors. When markets opened the following morning, April 20, Home Capital’s share price began to crater. A key concern was that the release came just hours before the Ontario government unveiled a series of measures to cool off Toronto’s housing market on the morning of April 20, including imposing a new 15-per-cent tax on foreign buyers. The combination of both was seen as a double-whammy, hitting Home Capital at a vulnerable time in the housing cycle. The bank jog then became a silent bank run, first for the bank's core providers of funding: other banks. On the morning of Friday, April 21, as investors scrambled out of Home Capital shares, a message popped up on financial advisers’ computer screens at Scotiabank. It was an internal notification from ScotiaMcLeod head Rob Djurfeldt, announcing that as part of an “ongoing review of 3rd-party products,” the bank would no longer allow the sale of Home Trust GICs. While some other banks had already limited sales of Home Trust products to the $100,000 CDIC cap, the memo suggested Scotiabank was going even further to cut off sales entirely. It was taken by many – including Home Capital itself – as a signal of a loss of faith in the company. Over the subsequent weekend, however, Scotia abruptly changed course and put Home Trust back on its platform with a $100,000 limit per client. Some players in the market jumped to their own conclusions that a regulator was involved in the reversal. This was the first regulatory intervention. It wouldn't be the last: “When Scotia dropped Home Trust on a Friday, only to put them back on the following Monday, everyone connected the dots,” that regulators were involved somehow, said Lee Matheson, managing director with Toronto-based hedge fund Broadview Capital Management Inc., which has had a short position in Home Capital for the past 18 months. Alex Besharat, senior vice-president at Scotia Wealth Management Canada, was part of the discussions held internally at Scotia that weekend about whether to put Home Trust’s GICs back on its platform. “There was a lot to that decision – it wasn’t just sort of a one-dimensional decision,” he said in an interview. OSFI turned down multiple requests for comment, saying it is prohibited from commenting on institutions it supervises or its supervisory work. By this point, retail depositors realized things were going south fast, and proceeds to start pulling their own money out of the bank at an accelerating pace. By Monday morning, April 24, Home Capital was facing a raft of withdrawals from depositors. The public nature of Scotiabank’s move was part of the reason for the rush, with Home Capital itself announcing Monday morning that the bank had put its products back onto its platform. The announcement served to ensure any financial advisers still unaware that other banks had quietly limited client exposure weeks earlier were now fully aware of at least one major bank’s moves to cap deposits at Home Trust. Many brokers and financial advisers quickly moved client funds to other institutions, unwilling to jeopardize their deposits for a slightly higher interest rate offered by Home Trust’s high-interest accounts. Home Capital officials watched the pace of client withdrawals climb quickly on Monday, and decided they needed to do more to reassure the markets. That same day, the company announced that Mr. Soloway – Home Capital’s founder, who had remained on the board after stepping down as CEO in 2016 – would depart entirely as a director “when a replacement with recognized expertise in financial services is named.” However, the company said Mr. Soloway would still stand for re-election at the annual meeting, which was then scheduled for May 11, but has since been delayed until June 29. It also announced Mr. Morton would step down as CFO, but only after the first-quarter financial results were filed. He would take on a new role as head of special projects, and would be replaced by Robert Blowes as interim CFO. Board chair Kevin Smith said the changes were aimed at rebuilding market confidence in the company. But the moves were again too little, and too late. The first admission by HCG itself that it was on the verge came on April, duly noted here. On Wednesday, April 26, the company made its first disclosure to alert the markets about the run on Home Trust’s savings accounts, saying deposits in high-interest savings accounts were down by almost $600-million to $1.4-billion from $2-billion at the end of March. The announcement sparked a far broader panic, and was the first indication that many in the public had of the size of the company’s problems. Savings account withdrawals would accelerate rapidly through the subsequent days, leading to a classic unstoppable run on the bank caused by depositor panic. The company most recently revealed Home Trust has just $125-million left in its high-interest savings accounts, a decline of over 90 per cent since late March. And the punchline of what until now was not known: the regualtor intervention amd the last minute rescue attempt: Canada hasn’t seen a run on a bank such as this in decades, and many in the current crop of regulators have no personal experience dealing with the sort of crisis that unfolded in late April at Canada’s largest alternative mortgage lender. A source said regulators began co-ordinating discussions “early on” in the crisis, before Home Capital was front page news, but no one anticipated the company was so vulnerable. Last summer, OSFI had no concerns with the company’s capital levels, liquidity or stress test results, according to another person familiar with the matter. But as the week of April 24 progressed, regulators grew worried they may not be able to halt the company’s slide. At one meeting involving officials from OSFI, CDIC and the federal finance department, there was discussion that Home Capital could collapse by early May, based on the pace of withdrawals and its remaining capital, the source said. Participants even discussed a scenario where Home Trust could fail, which would require Finance Minister Bill Morneau to sign an order giving OSFI control of the bank, the source said. In the first two weeks of the crisis, top leaders and their staff – including OSFI, the Bank of Canada and Canada Deposit Insurance Corp. – were on the phone “every hour” to discuss their response, the first source said. At one point, a meeting at one regulator’s headquarters was interrupted repeatedly as officials left the room in a steady stream to answer urgent calls about Home Capital, the source said. A focus of regulators has been on ensuring Home Capital remains “orderly,” the two sources said, and especially that there is no contagion to other institutions, including other specialty lenders such as Equitable Bank. Key regulators who monitor system risks in the financial system – including the federal finance department – have also held Sunday morning conference calls to discuss plans for the week ahead, with the heads of the organizations typically on the calls. The rest of the story is mostly known to regular readers: for now it concludes with Brenda Eprile, the company's new Chair and former OSC executive director, trying to instill confidence. Ms. Eprile said a committee of the board is also actively talking to new CEO and CFO candidates as one of the next top priorities. She said she feels “a real sense of optimism” that Home Capital is now stabilizing, especially after strong new directors like Mr. Hibben joined the board last week and immediately rolled up their sleeves to tackle a host of issues. “There’s a real sense that we can make it,” she said. “We just have to be very hunkered down and do our plan, and the company can be restored to a very positive future.” And if that doesn't work, there are always Canada's taxpayers. In a separate interview, the Globe and Mail spoke to Canada's Finance Minister who said he expects a private solution to the crisis at Home Capital which still has "strong assets", and added that the government is very focused on Home Capital Group, and repeated that he doesn't see Home Capital's problems as being a broader real-estate market problem. The punchline: while he believes a bailout is "unlikely to be necessary", he won't rule out a bailout of Home Capital Group. For the full Home Capital sage, there is much more in the full Globe and Mail article.
Moodys Slashes Ratings On 6 Canadian Banks, Fears Asset-Quality Deterioration, Soaring Household Debt
Amid Poloz-described "unsustainable prices" in various cities, and just days after the collapse of Canadian mortgage lender Home Capital Group and our discussion of the dire state of Canadian savers (and their record household debt), Moodys has cut the ratings on six of Canada's largest banks because of "ongoing concerns that expanding levels of private-sector debt could weaken asset quality in the future." As a reminder, even Bank of Canada Governor Stephen Poloz noted that Toronto is out control tonight while answering questions following a speech in Mexico City... "pretty sure recent gains in Toronto home prices were not sustainable and that the city’s housing market had elements of speculation" "Financial stability is part of the Bank of Canada’s monetary policy decision making, but the central bank’s primary mission is inflation targeting,... it would be odd to use interest rates to target home prices in just one city." Perhaps Mr. Poloz, but, as we showed previously, it doesn’t take a genius to figure out that this will end in tears. Even the big Canadian banks are fretting. “Let’s drop the pretense. The Toronto housing market and the many cities surrounding it are in a housing bubble,” Bank of Montreal Chief Economist Doug Porter warned clients. But the bubble’s deflation would push the city into a fiscal and financial sinkhole. So that's the supposed 'asset' side, and to show just how bad the debt situation in Canada truly is, here are some more charts which are largely self-explanatory. And perhaps the most important - and troubling - chart of all: And of course the bank run at Home Capital Group... It should hardly be a surprise that Moodys today downgraded the Baseline Credit Assessments (BCAs), the long-term ratings and the Counterparty Risk Assessments (CRAs) of six Canadian banks and their affiliates, reflecting Moody's expectation of a more challenging operating environment for banks in Canada for the remainder of 2017 and beyond, that could lead to a deterioration in the banks' asset quality, and increase their sensitivity to external shocks. The banks affected are: Toronto-Dominion Bank, Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Canada, National Bank of Canada, and Royal Bank of Canada. The BCAs, long-term debt and deposit ratings and CRAs of the banks and their affiliates were downgraded by 1 notch, excepting only Toronto-Dominion Bank's CRA, which was affirmed. The short term Prime-1 ratings of the Canadian banks were affirmed. All relevant ratings for these banks continue to have negative outlooks, reflecting the expected introduction of an operational resolution regime in Canada. "Today's downgrade of the Canadian banks reflects our ongoing concerns that expanding levels of private-sector debt could weaken asset quality in the future. Continued growth in Canadian consumer debt and elevated housing prices leaves consumers, and Canadian banks, more vulnerable to downside risks facing the Canadian economy than in the past." said David Beattie, a Moody's Senior Vice President. In the same action, Moody's affirmed the BCAs, long-term ratings and CRAs of CIBC Mellon Trust (CIBC Mellon), the Fédération des caisses Desjardins du Québec (the Fédération) and Caisse centrale Desjardins. In view of today's actions, Moody's does not expect any upward rating pressure on the affected banks in the near term. However, the Canadian banks' ratings could be revised upwards if macro-economic conditions in Canada improve and the Canadian banks maintain sound financial metrics. The affected banks' ratings could be downgraded if their fundamentals weaken, as evidenced by an even more challenging operating environment and/or deterioration in their financial metrics. * * * Here is the full ratings rationale by bank... Moody's considers that weakening credit conditions in Canada -- including an increase in private-sector debt to GDP to 185.0% as of the end of 2016, up from 179.3% for 2015 -- present increasing risk to Canadian banks' asset quality and profitability. This increase has been led by household debt, which is now at a record high of 167.3% of disposable income (as at Q4 2016) and accompanying house price appreciation. Despite macro-prudential measures put into place by Canadian policymakers in recent years -- which have had some success in moderating the rate of housing price growth -- house prices and consumer debt levels remain historically high. Business credit, the other component of private-sector debt, has also grown rapidly, at a 6.2% CAGR over the past 3 years. We do note that the Canadian banks maintain strong buffers in terms of capital and liquidity. However, the resilience of household balance sheets, and consequently bank portfolios, to a serious economic downturn has not been tested at these levels of private sector indebtedness. Toronto-Dominion Bank (TD, Aa2/Aa2 negative, a1); TD's strong ratings are attributable to its very strong domestic retail franchise -- which generates stable and recurring profitability and its business mix. This strength is due to leading market share positions in many personal & commercial financial services products, where TD typically has market shares in the high teens and holds first or second positions. TD is the most retail oriented of its Canadian peers, with approximately 90% of earnings coming from retail (combined Canadian personal & commercial, wealth management and US personal & commercial, excluding corporate). While CM income has increased over recent quarters and capital allocated to the wholesale business is rising, we expect that reliance on this inherently volatile source of income will remain relatively modest. Through acquisition and organic growth, TD has increased its exposure to unsecured Canadian consumer credit risk in recent years. In our view, however, the strength and stability of the earnings from TD's Canadian personal and commercial banking franchise remain the primary credit strength supporting its ratings. The ratings of TD's US affiliates benefit from support from the parent, and as such are also affected by this action. Bank of Montreal (BMO A1/A1 negative, a3); BMO is one of the six major banks in Canada which benefit from the protection of significant barriers to entry and the stability of a prudent regulatory environment. Although its Canadian retail market shares are towards the lower end of the Canadian peer group, BMO has double digit market shares across all significant retail financial services and products, providing scale and recurring earnings power in its home market. In our view, however, the strength and stability of the earnings from BMO's Canadian personal and commercial (P&C) banking franchise remain the primary credit strength supporting its ratings. BMO has a strong and improving US regional banking presence through BMO Harris, which adds important diversification away from reliance on Canadian P&C earnings. However, BMO does not enjoy the same franchise strength and pricing power in the more competitive US market that it does in Canada. The ratings of BMO Harris and affiliates benefit from support from the parent, and as such are also affected by this action. Bank of Nova Scotia (BNS A1/A1 negative, a3); BNS is the most internationally active of the Canadian banks with approximately half of its earnings generated outside of Canada. BNS has taken significant measures to increase its profitability that signal a fundamental shift away from the bank's traditionally low risk appetite. While the bank's strategic actions are intended to enhance current profitability -- in 2016, BNS reported domestic net interest margin lower than the six largest Canadian banks' average- in our view, they increase the prospect of future incremental credit losses. While BNS had strategically grown its credit card and auto finance portfolios - both of which are particularly prone to deterioration during an economic downturn and exhibit higher defaults and loss severities than mortgage portfolios -- in recent years, growth in 2016 was flat. In addition, the bank has made a series of acquisitions away from its strong domestic franchise towards higher-growth but less stable international markets. BNS has aspirations to continue to grow its international earnings, which in Moody's view adds to bondholder risk. Canadian Imperial Bank of Commerce (CIBC A1/A1 negative, a3); CIBC is the most reliant of the Canadian banks on domestic P&C earnings, which generate approximately 65% of total earnings, excluding Corporate. In our view, however, the strength and stability of the earnings from CIBC's Canadian personal and commercial banking franchise remain the primary credit strength supporting its ratings. CIBC has the second lowest proportionate exposure to unsecured and non-real estate secured consumer debt as a percentage of domestic consumer assets (roughly 11.5%), reflective of its very large book of insured mortgages. CIBC is one of the six major banks in Canada that benefit from the protection of significant barriers to entry and the stability of a prudent regulatory environment. Although its Canadian retail market shares are mid-range relative to its Canadian peers, CIBC has solid double digit market shares across all significant retail financial services and products, providing scale and recurring earnings. National Bank of Canada (NBC A1/A1 negative, baa1); NBC's dominant position in commercial banking and strong second place share of market in retail banking in Québec are the primary credit strengths supporting its high ratings. The stability of the recurring earnings power of NBC's regional retail franchise is, in Moody's view, highly unlikely to be challenged. That being said, NBC's asset base (CAD234 billion as of Q1 2017) and national deposit share (roughly 4%) are small relative to the other large Canadian banks whose branch systems are more national in scale. In our view, however, the strength and stability of the earnings from NBC's Canadian personal and commercial banking franchise remain the primary credit strength supporting its ratings. While each of the major Canadian banks enjoys the benefits of superior pricing power due to sustainable large market shares in many significant retail and commercial products and services, this is true for NBC only in the context of its regional market, the province of Québec. As such, the challenges in geographic diversification and earnings stability and the Québec credit concentrations offset partially the strength in local market share and sustainability. NBC is the Canadian bank most reliant upon inherently less stable capital markets earnings, which generated 38% of total earnings, excluding Corporate for 2016 (38% for 2015.) Royal Bank of Canada (RBC A1/A1 negative, a3 ); RBC's ratings reflect its profile as a strong and diversified universal bank with sustainable leading market shares across many retail products and services in its home market. The stable earnings from RBC's domestic Personal and Commercial franchise are a key credit strength. RBC has had very low earnings volatility, supported by the stabilizing effect of the recurring profitability of RBC's solid domestic retail banking franchise. However, over the past four years RBC has demonstrated rapid growth in its Capital Markets business, led by growth in its US corporate loan book and the repo and securities finance business. We believe that RBC's US-focused Capital Markets growth strategy increases its exposure to risks that could more rapidly erode its creditworthiness in volatile or adverse market conditions, and is therefore negative for the credit. To date, this risk has been well managed and its performance has been very stable. Maintaining this performance through more volatile markets will be key to RBC's longer term risk management track record. We do not expect that this business will continue on this growth trajectory, and, in fact, that capital committed to the Capital Markets business will be more constrained. Management plans to substantially grow the earnings of its recently acquired, California-based private and commercial bank, City National Bank, (deposits Aa3 stable, a2) both organically and through targeted acquisitions. Growth in the City National business presents less credit risk than continued growth in the Capital Markets area, in our view. The ratings of two affiliates, RBC Capital Markets LLC and RBC (Barbados) Trading Bank Corporation were also affected by this action. In each case, both long and short term ratings were downgraded. Fédération des caisses Desjardins du Québec (Aa2/Aa2 negative, a1 ); The Fédération is a cooperative entity responsible for governance and oversight activities for Desjardins Group (the Group). It acts as a control and supervisory body over the individual member caisses. The Fédération's pivotal importance to the Group's operations and performance, the application of regulatory supervision to the Group as a whole, as well as the strong strategic and financial cohesion among member caisses with a well-developed mutualist support framework, lead us to factor the strength of the Group into the Fédération's BCA. The Group has a secure retail banking franchise in rural Québec as well as strong capitalization and limited reliance on wholesale funding. Its regional banking concentration in Québec is offset in part by the Group's national insurance and wealth management business. The Fédération's ratings were affirmed despite the Macro Profile change because Moody's believes its operations to be largely isolated to the province of Quebec (which has experienced lower house price appreciation than other provinces) and because a large proportion of Desjardins' net income is derived from non-banking sources, such as life and property and casualty insurance. CIBC Mellon Trust (CIBC Mellon A1/A1 stable, a1); CIBC Mellon is a major player in the Canadian custody market, underpinning its franchise value. The operations and technology platform provided by BNY Mellon lends a further competitive advantage. BNY Mellon is the largest custodian, globally, and its operating platform allows CIBC Mellon to benefit from economies of scale and service not available to its primary domestic competitor. CIBC Mellon's risk management and control environment is strong, with an appropriate emphasis on operational risk issues and effective supervision by the joint venture's owners. CMT does not make loans (other than short-term overdrafts to custody clients) but incurs credit risk through its securities portfolio. The investment portfolio is made up largely of short-duration Canadian government and provincial bonds as well as corporate debt. CIBC Mellon's ratings were affirmed despite the change in the Macro Profile because Moody's believes its custody bank business model is directly unaffected by high consumer debt as it does not lend to consumers.
After two years of recurring warnings (both on this website and elsewhere) that Canada's largest alternative (i.e., non-bank) mortgage lender is fundamentally insolvent, kept alive only courtesy of the Canadian housing bubble which until last week had managed to lift all boats, Home Capital Group suffered a spectacular spectacular implosion last week when its stock price crashed by the most on record after HCG revealed that it had taken out an emergency $2 billion line of credit from an unnamed counterparty with an effective rate as high as 22.5%, indicative of a business model on the verge of collapse . Or, as we put it, Canada just experienced its very own "New Century" moment. One day later, it emerged that the lender behind HCG's (pre-petition) rescue loan was none other than the Healthcare of Ontario Pension Plan (HOOPP). As Bloomberg reported, the Toronto-based pension plan - which represented more than 321,000 healthcare workers in Ontario - gave the struggling Canadian mortgage lender the loan to shore up liquidity as it faces a run on deposits amid a probe by the provincial securities regulator. Home Capital had also retained RBC Capital Markets and BMO Capital Markets to advise on “strategic options” after it secured the loan. Why did HOOPP put itself, or rather its constituents in the precarious position of funding what is a very rapidly melting ice cube? The answer to that emerged when we learned that HOOPP President and CEO Jim Keohane also sits on Home Capital’s board and is also a shareholder. But how did regulators allow such a glaring conflict of interest? According to the Canadian press, Keohane had been a director of Home Capital until Thursday, but said he stepped away from the boardroom on Tuesday to remove the conflict of interest when it became clear HOOPP might step in as a lender. Keohane further clarified on Friday that he doesn’t view the Home Capital investment as risky because the pension plan will be provided with $2 worth of mortgages as collateral for every $1 it lends to Home Capital. “We take comfort from the underlying asset portfolio, so we are not looking at Home Capital as a credit,” said Mr. Keohane in an interview with Business News Network television. He added that a correction in the housing market is not of great concern, since the values of homes would need to plummet by more than 65 per cent for the fund to make no return beyond the value of its principal commitment. Furthermore, it appears that Canada's pensioners are priming all other company lenders: Keohane also said that the funding syndicate would rank above Home Capital’s other lenders. “We have security interest in the collateral we’ve received, so we have the right to sell that collateral if we don’t get paid. And then the balance that’s left over would go to recovery for other creditors.” The implication is that as long as HCG's mortgages dont suffer greater than 50% losses, HOOPP's pensioners should be money good. Of course, if this is indeed Canada's "subprime moment", any outcome is possible. As for other lenders, or the prepetition (because there will be a petition here, the only question is when and in what form) equity, that's some $4 billion in assets that was just stripped from existing collateral. "The Best Price May Come From Breaking Up The Company" In any case, the company's frenzied, emergency measures to stabilize the near-insolvent mortgage lender were not nearly enough, and despite HCG stock posting a modest rebound on Friday between hopes of a rumored sale and a short squeeze, those hopes may be dashed soon because as the Globe and Mail reports, the depositor bank run that gripped Home Capital Group in the past week, only got worse after the company revealed just how precarious its funding situation had become. First, any hope the company, or rather its investors may have held of a sale, appear dashed. Investment banking sources cited by the G&M said "the best possible price may come from breaking up the company and selling portions of its mortgage portfolio to regional financial institutions." Which also implies that aside from a few select assets, there is no equity value left, or in other words, any potential buyer is now motivated to wait until HCG liquidates, and then picks off the various assets in bankruptcy court. There are structural limitations as well: Home Capital currently holds $18-billion in home loans outstanding, "a portfolio that would be difficult to swallow for rivals in the alternative mortgage sector, such as credit unions, small mortgage lenders, Montreal-based Laurentian Bank and Edmonton-based Canadian Western Bank." These institutions, along with private equity firms, could still bid for pieces of Home Capital, the G&M admits. The only question is why they would do so before a bankruptcy filing. While one prominent name features on the list of potential buyers, that of PE giant J.C. Flowers whose CEO J. Christopher Flowers earlier this year said he expected to expand the company’s Canadian real estate lending business, Canada’s six big banks are notable for their absence on a list of bidders. The reason is that Home Capital lends money to home buyers who have been turned down by the major banks and none of these institutions is expected to enter the alternative mortgage sector by acquiring the company. National Bank of Canada proactively called the equity analysts who follow the company this week to say it would not bid on Home Capital after being asked if it was a potential buyer. Needless to say, the big banks would be quite delighted if one of their "bottom picking" competitors would suddenly go bankrupt. "When you have a bank run people get spooked" Which brings us to the most imminent risk facing Home Capital Group, and its subsidiary, Home Trust. Recall, that on Thursday we observed that as concerns about HCG's viability mounted, depositors were quietly pulling their funding from from savings accounts at subsidiary Home Trust. By Wednesday, when Home Capital revealed it was seeking a $2-billion loan to backstop its sinking savings deposits, shareholders ran for the exits, driving down the company’s share price by 65 per cent on Wednesday alone, and heightening the sense of panic. On Friday, the company revealed that high-interest savings account balances fell another 36% to $521-million by Friday morning, down by a whopping $293 million from $814-million Thursday and more than $2-billion a month ago. In other words, had it not been for the emergency HOOPP loan, the company would likely be insolvent as of this moment following what may be the biggest bank run in recent Canadian history; which also explains why the interest rate on the loan is above 20%. “When you have a run on the bank, people get spooked and they sell and ask questions later,” said a Bay Street investment banker. “It’s investor psychology that takes over.” As is usually the case, regulator appeared on the scene.... just one day too late. Canada’s banking industry regulator, the Office of the Superintendent of Financial Institutions (OSFI), has gathered data from other financial institutions this week, both to monitor for signs of a broader depositor panic and to track where funds are moving as they leave Home Trust. OSFI sent an urgent request Wednesday to several smaller and mid-sized financial institutions and credit unions to provide the regulator with up-to-date information about their savings accounts, according to a source. Specifically, OSFI wanted to know the institutions’ most recent account totals for high-interest savings accounts, as well as data on recent redemptions and current levels of high-quality liquid assets. The request, which the OFSI said had to be fulfilled "as soon as institutions are able", is seen as an attempt to take the pulse of the market by tracking where deposits flowing out of Home Capital may be going, and to gauge whether there is any contagion among other institutions. In recent days, some smaller and mid-sized institutions have also struck up early-stage discussions about whether multiple institutions could join together to explore a deal to buy some of Home Capital’s assets. As for Canada's big banks, they have already decided that HCG won't survive. Several months ago, Canaccord Genuity Group Inc. told its financial advisers they could no longer steer investors to high-interest savings accounts at Home Capital or rival alternative mortgage lender Equitable Bank. Client money already placed with either bank had to be moved within 60 days. Then, after Home Capital revealed in March it was under investigation by the Ontario Securities Commission over its disclosure practices, Canadian Imperial Bank of Commerce introduced a cap of $100,000 per client for purchases of Home Capital guaranteed investment certificates (GICs), which is the maximum level covered by Canada’s deposit insurer. A spokesperson from Royal Bank of Canada said that, “several weeks ago” the bank introduced a $100,000 cap on Home Capital GICs bought through a full-service broker, although there were no limits for purchases through the firm’s discount brokerage. On Thursday, RBC also released the following entertaining price target scenario: it still has a price target of $8 but fear not, even if RBC is wrong, it promises at least $4/share in residual value. We are not quite as optimistic. Additionally, late last week, Bank of Nova Scotia said it would stop selling all GICs sold by Home Trust, but said Monday that policy was amended to a limit of $100,000. Bank of Montreal’s brokerage unit also confirmed it has a $100,000 limit on Home Trust GICs but would not say when it went into force. As G&M adds, the OSC news shook investors, but the panic was heightened as news of the banks' moves to cap investor deposits slowly seeped through Bay Street in subsequent days, raising concerns that major financial institutions were pulling away from Home Capital. "We Are Out Of The Position" When asked if Home Capital could survive this run on its deposits, Keohane - formerly at HOOPP, and the company's last remaining source of funding - said it was possible. “I think it’s a viable business,” he said. “Their cost of funding is going to go up, which may impact earnings… it’s always a possibility that some other institution may have an interest in taking the entity over. If you can have access to a lower funding cost, I mean, it’s quite an attractive purchase.” Most disagree, and it is safe to assume that the depositor run won't stop until every last dollar held at HCG has been withdrawn. Meanwhile, late on Friday, Home Capital’s second biggest shareholder, Calgary-based QV Investors disclosed that it liquidated its position, selling 8.4 million shares. QV Investors previously held a 12.8% stake in Home Capital. Toronto-based Turtle Creek Asset Management is Home Capital’s biggest shareholder with 13.6% stake. On Saturday another prominent investor bailed, when Calgary-based Mawer Investment Management sold 2.75 million shares of the alternative lender, CIO Jim Hall said told Bloomberg in a phone interview. “We are out of the position,” Hall said. Mawer also has reduced holdings in Canadian alternative- lender Equitable Group. All these investors will now be forced to explain to their LPs how they missed a ticking timebomb which so many, this website included, had warned about for year. Home Without The Capital Group As for Home Capital Group, or more aptly Home Without The Capital Group, the future is bleak, and a bankruptcy liquidation appears the most likely outcome. What impact such an event will have on the broader Canadian housing market remains to be seen. Last week, shortly after HCG's rescue loan announcement stunned the otherwise sleep Toronto tape, the Canadian housing regulator warned of "strong evidence of housing-market problems." Looking back in a few months, that may prove to be a vast understatement.
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This is a Real-time headline. These are breaking news, delivered the minute it happens, delivered ticker-tape style. Visit www.marketwatch.com or the quote page for more information about this breaking news.
On Apr 5, we issued an updated research report on E*TRADE Financial Corporation (ETFC). The company's several restructuring moves and focus on boosting its trading business led to impressive outcomes.
Submitted by Wolf Richter of Wolf Street Based on fundamentals? You gotta be kidding. Residential property sales in Greater Toronto soared 17.7% year-over-year to 12,077 homes, according to the Toronto Real Estate Board (TREB). New listings jumped 15.2% to 17,052. Prices for all types of homes, based on the MLS Home Price Index Composite “Benchmark,” soared 28.6%. The “average” selling price soared 33.2%! That average selling price of C$916,567 is up from C$688,011 a year ago. Over the past five years, it has doubled! The heavenly manna was spread across the spectrum. For condos, the average price in Greater Toronto soared 33.1% to C$518,879; for townhouses it soared 32.9% to C$705,078; for semi-detached houses, 34.4% to C$858,202; and for detached houses, 33.4% to C$1,214,422. Even the house price bubble in Beijing cannot compete with this sort of miracle; new house prices there increased only 22% year-over-year in February. And Sydney’s fabulous house price bubble just flat out pales compared to the spectacle transpiring in Toronto, with prices up only 19% in March. Vancouver has its own housing bubble to deal with. But there, the government of British Columbia has tried to tamp down on wild speculation with various measures, including a transfer tax aimed squarely at foreign non-resident investors, with “mixed” success. Now the great fear in Toronto’s real estate circles is that the government of Ontario might impose similarly cruel and unusual punishment on the participants in this spectacle. Some measures are on the table, with folks wondering how to stop the bubble from inflating further and causing even greater harm to the real economy when it deflates, as all bubbles eventually do. They’re reluctant. It seems they want to see how BC’s measures are washing out in Vancouver. The central government too is trying to fine-tune some macroprudential measures, but they’ve had absolutely no effect on Toronto’s housing bubble. And the Bank of Canada, which has been fretting about the housing bubble for a while – always couched in its very careful terms – refuses to raise rates. Everyone is talking. No one dares to do anything real about Toronto’s house price bubble. In Toronto, according the real estate folks, it’s all based on fundamentals. It’s based on supply and demand and very rational calculated thinking, and there is no bubble in sight, lenders are just fine, and if Canadians are locked out of the housing market, so be it, it’s just a shortage of housing, really. So TREB President Larry Cerqua is glad the efforts to tamp down on it all have not come to fruition, in part due to TREB’s vigorous lobbying: “It has been encouraging to see that policymakers have not implemented any knee-jerk policies regarding the GTA housing market,” he said in a statement. “Different levels of government are holding consultations with market stakeholders and TREB has participated and will continue to participate in these discussions,” he said. “Policy makers must remember that it is the interplay between the demand for and supply of listings that influences price growth.” Singing a similar tune, Jason Mercer, TREB’s Director of Market Analysis, explained the basic supply and demand problem: “Annual rates of price growth continued to accelerate in March as growth in sales outstripped growth in listings,” he said. “A substantial period of months in which listings growth is greater than sales growth will be required to bring the GTA housing market back into balance.” And he told policy makers to tread carefully: “As policy makers seek to achieve this balance, it is important that an evidence-based approach is followed,” he said. This is a gravy train, and it must be allowed to speed on until the last cent has been extracted. It doesn’t take a genius to figure out that this will end in tears. What we don’t know yet is when it will end in tears, and whose tears it will end with. But we already know: When it does end in tears, real estate organizations will first be denying it, and then they’ll be clamoring for a bailout of their stakeholders – so it will end in the tears of others. Even the big Canadian banks are fretting. “Let’s drop the pretense. The Toronto housing market and the many cities surrounding it are in a housing bubble,” Bank of Montreal Chief Economist Doug Porter warned clients. But the bubble’s deflation would push the city into a fiscal and financial sinkhole
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